Soaring yields push Italy to the brink

The shock wave from Greece’s referendum bombshell rang through European debt markets Wednesday, raising new doubts that the crisis can be stopped.

Italy’s yields approached levels at which its debt burden is thought to become unsustainable and the region’s bailout fund postponed a bond sale, inviting questions over the ability of the eurozone to raise money and finance its rescue plan.

“Prospects for an orderly resolution of Euroland’s crisis have never been bleaker than they are now,” Carl Weinberg, chief economist at High Frequency Economics, said in a note.

On Wednesday, Italian Prime Minister Silvio Berlusconi, facing pressure to resign, even from the president of Italy, devised plans for quelling market turmoil and his Cabinet passed austerity measures.

Mr. Berlusconi then heded off to Cannes, France, for a meeting of Group of 20 countries.

Yields on Italian 10-year bonds remained in excess of 6.1% Wednesday, while spreads over safe-haven German bonds moderated somewhat after rising to a euro-era high the day before.

Mr. Weinberg said he foresees a target of 8% to 10% yields on Italian debt.

“If it has to pay those yields to finance itself, Italy is dead, and the sovereign crisis just blew up,” he said.

Among the 17 countries that compose the currency bloc, Italy’s output is the third-largest, accounting for 17% of GDP.

With ¤1.6-trillion in outstanding debt, Italy has the eurozone’s largest bond market, and smaller than only those of Japan and the United States.
“Europe can’t afford to have serious default risk expressed in Italian bonds. It simply doesn’t have the wherewithal to protect against that or ringfence it,” said Mark Chandler, head of Canadian fixed income and currency research at RBC Capital Markets.

But George Papandreou’s referendum gambit exposes precisely that risk. Just a week after the “summit to end all summits,” during which a comprehensive plan to protect Europe’s banks and sovereigns was hammered out, the Greek prime minister threw the region back into crisis and another round of emergency summits.

On Wednesday, Mr. Papandreou was summoned to the French Riviera by the leaders of France and Germany to explain his decision to put Greece’s membership in the monetary union to a national referendum.

“The Greeks must say quickly and without ambiguity whether they choose to keep their place in the eurozone or not,” said French Prime Minister Francois Fillon.

The answer to that question won’t come before December. The meantime promises to be filled with uncertainty and volatility, particularly for those sovereigns already on shaky fiscal ground.

The referendum puts on hold the Greek haircut and keeps alive knock-on risks in the European banking sector.

“If the grand master plan goes down, you have to rethink those other support mechanisms that were part of the package that would have helped Italy,” Mr. Chandler said.

If Greece — a country of just 11 million and an economy accounting for just 2.5% of regional GDP — can provide the spark for a debt crisis, Italian insolvency could prove